Energy giant Encana must fight for survival in new home

Encana must fight for survival in new home

CALGARY — Thousands of Encana Corp. employees this summer will move into their new headquarters spanning the top levels of The Bow — a gargantuan structure of glass, steel and green architecture that dwarfs the iconic Calgary Tower.

It should be a time to look up, but many must be wondering if they’ll soon have to make the 236-metre trip down to the bottom of Western Canada’s tallest tower, or, worse, remain at their desks and watch another company’s name replace Encana’s sharp new signage.

Canada’s largest natural gas producer is facing years of historic low natural gas prices with little time or money for it to move into more lucrative liquid-based products. More than 95% of Encana’s production continues to come from natural gas.

“We did not see a 50-to-one oil-to-gas ratio coming,” said Ryder McRitchie, Encana’s vice-president of investor relations. “As humble as we are when we say that, most of the people that I meet with on the investor side say who did?”

Some, however, did see the natural gas glut coming far sooner. For instance, natural gas producers such as Devon Energy Corp. and Chesapeake Energy Corp. have aggressively refocused on oil and natural gas-based liquids in recent years.

‘When you’re a company of that size, it is impossible to be nimble when you’re trying to change to such a large degree’

Encana’s management has gone to great lengths to highlight the liquids that lie beneath its shale holdings in the Haynesville region of the southwestern United States, Tuscaloosa to the east and the Duvernay fields that straddle Alberta and British Columbia.

The plan is for Encana to grow liquids production to 80,000 barrels per day by 2015 from under 30,000 bpd currently, Mr. McRitchie said. That figure could end up being even higher once the company works out how much it can pump from its newer properties in the Tuscaloosa and Duvernay regions.

But analysts argue those plays won’t start producing fast enough.

“When you’re a company of that size, it is impossible to be nimble when you’re trying to change to such a large degree,” said Eric Nuttall, energy portfolio manager at Sprott Asset Management in Toronto. “It is not like you’re going to decide, ‘Okay, we’re going to become a light oil company,’ and six months later you’ve got a large production capacity in light oil.”

Ironically, some of Encana’s current difficulties stem from the 2008 decision to spin off the company’s oil sands assets into what is now a very profitable Cenovus Energy Inc., which just this week won regulatory approval to begin developing a third site near northern Alberta’s Narrows Lake.

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If Encana really wants to ramp up its liquids production, experts say it will have to buy the kinds of assets it previously shedded. Not Cenovus, to be sure, since it now boasts a market value more than $9-billion higher than Encana’s. But small-to-mid-cap players such as TriOil Resources Ltd. and Renegade Petroleum Ltd. are trading at distressed levels, Mr. Nuttall said, making them vulnerable to acquisition and ideal targets if Encana is going to fast track its growth in liquids.

Acquisitions, though, require funding and Encana’s debt is already north of $7.5-billion, or more than half the company’s total market cap. But without some new income sources, the company will face a cash shortfall in excess of $1-billion by 2014-2015, RBC Capital Markets warned on Friday. To avoid a credit ratings downgrade, RBC said Encana will likely need to consider further asset sales, joint ventures, equity offerings or cut its generous dividend.

Of course, Encana could make an all-stock buyout offer, and, as the best-performing large-cap Canadian energy stock so far this year, now would be a perfect time. Encana’s stock is up about 6% in 2012, though Mr. Nuttall said this is just a “perversion” in the markets resulting from the disconnect between oil-weighted names and natural gas firms rather than a reflection of Encana’s attractiveness.

Complicating matters is that the assets Encana has seen for sale are expensive and fully valued, Mr. McRitchie said. But he added the company has started “a couple of processes to look at potentially bringing in a joint-venture partner that would help accelerate the spending and valuation of some of our liquids plays.”

Should a suitable JV partner not emerge, Encana will be left with the unenviable task of ramping up liquids production on its own under a very tight budget, leaving little hope dramatic growth will happen anytime soon. “And if you’re not growing production, you’re losing investors’ attention,” Mr. Nuttall said.

If investors tune out, interest from potential acquirers would undoubtedly increase. Encana has found itself in similar situations in recent years. In 2005, Royal Dutch Shell PLC — which is moving deeper into Canadian natural gas through plans to build a giant liquefied natural gas (LNG) terminal on the west coast — was rumoured to be a suitor when Encana’s stock price was far higher than it is today.

But the possibility of a takeover is even more likely today because of the growing appetite among Asian energy giants for any asset that would give them exposure to North America’s potentially massive LNG export market.

“Large-cap equities are being priced at rock bottom levels and the cost of capital is so low that I’m surprised you haven’t seen any big cap deal flow and I still think there is a reasonably likely chance you will soon,” said Andrew Potter, a Calgary-based analyst at CIBC World Markets.

“Then you go through the list and look at what is strategic and cheap and out of favour. Encana would have to be at the higher end of that list in terms of names most likely to be taken out.”

Any number of global energy players would be interested in owning Encana, though the company’s sheer size means any proposal would likely require approval by the Canadian federal government. Under the Investment Canada Act, acquisitions of large domestic firms by foreign entities must pass an ambiguously-defined “net benefit test” before a deal can go through.

Ever since Ottawa used the Act for only the second time in Canadian history last year to reject BHP Billiton Ltd.’s $40-billion hostile takeover attempt of Potash Corp. Of Saskatchewan Inc., many have assumed acquisitions of other strategic national assets — and Encana could arguably qualify — would be off the table.

However, more than half the company’s production actually comes from wells based in the U.S., which, Mr. Potter argues, makes the net benefit question easier to answer.

Until that question is asked, however, Encana employees should enjoy their luxurious new digs. But they might not want to get too comfortable.